Question

Problem 9-15 WACC Estimation On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $30 million in new projects. The firm's present market value capital structure, here below, is considered to be optimal. There is no short-term debt. Debt Common equity Total capital $30,000,000 30,000,000 $60,000,000 New bonds will have an 10% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders' required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so the dividend yield is $1.20/$30 - 4%.) The marginal tax rate is 40%. a. In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Enter your answer in dollars. For example, $1.2 million should be entered as $1200000. b. Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares of equity, what is its WACC? Round your answer to two decimal places. ole C. Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC? No numbers are required to answer this question. I. rs and the WACC will decrease due to the flotation costs of new equity. II. rs will increase and the WACC will decrease due to the flotation costs of new equity. III. rs will decrease and the WACC will increase due to the flotation costs of new equity. IV. rs and the WACC will not be affected by flotation costs of new equity. V. r, and the WACC will increase due to the flotation costs of new equity.

Answer 1

Investment to be financed by common equity = Total.investment *weight of equity

= 30,000,000*1/2

=$15,000,000

B.WACC = cost of debt*weight of debt + cost of equity*Wright of equity

10%(1-40%)*1/2 + 12%*1/2

= 9%

V.rs and WACC will increase due to flotation cost of new equity